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MULTIPLE CHOICE QUESTIONS

Retained Earnings Dividends

<b>1. [M86&num;14] When a property dividend is declared and the book value of the property exceeds its market value, the dividend is recorded at the a. Market value of the property at the date of distribution. b. Market value of the property at the date of declaration. c. Book value of the property at the date of declaration. d. Book value of the property at the date of distribution if it still exceeds the market value of the property at the date of declaration. <b>2. [N87&num;15] How would the declaration of a liquidating dividend by a corporation affect each of the following?

Total Stockholders'

Contributed CapitalEquity a. b. c. d. No effect Decrease Decrease No effect

Decrease Decrease No effect No effect

<b>3. [M87&num;20] A company declared a cash dividend on its common stock in December 1986, payable in January 1987. Retained earnings would a. Increase on the date of declaration. b. Not be affected on the date of declaration. c. Not be affected on the date of payment. d. Decrease on the date of payment. <b>4. [M87&num;21] How would retained earnings be affected by the declaration of each of the following?

Stock DividendStock Split a. b. c. d. Decrease No effect No effect Decrease

Decrease Decrease No effect No effect

Treasury Stock

<b>5. [M89&num;10] The par-value method of accounting for treasury stock differs from the cost method in that a. Any gain is recognized upon repurchase of stock but a loss is treated as an adjustment to retained earnings. b. No gains or losses are recognized on the issuance of treasury stock using the par-value method. c. It reverses the original entry to issue the common stock with any difference between carrying value and purchase price adjusted through paid-in capital and/or retained earnings and treats a subsequent reissuance like a new issuance of common stock. d. It reverses the original entry to issue the common stock with any difference between carrying value and purchase price being shown as an ordinary gain or loss and does not recognize any gain or loss on a subsequent resale of the stock. <b>6. [M88&num;20] Treasury stock was acquired for cash at a price in excess of its original issue price. The treasury stock was subsequently reissued for cash at a price in excess of its acquisition price. Assuming that the par value method of accounting for treasury stock transactions is used, what is the effect on total stockholders' equity?

Acquisition ofReissuance of

Treasury StockTreasury Stock a. b. c. d. No effect Increase Decrease Decrease

No effect Decrease No effect Increase

<b>7. [N88&num;19] Treasury stock was acquired for cash at a price in excess of its par value. The treasury stock was subsequently reissued for cash at a price in excess of its acquisition price. Assuming that the cost method of accounting for treasury stock transactions is used, what is the effect of the subsequent reissuance of the treasury stock on each of the following? AdditionalTotal Paid-InRetainedStockholders' CapitalEarningsEquity a. b. c. d.

Decrease Increase Increase No effect Decrease Increase No effect No effect

No effect Increase Increase No effect

Stock Options, Warrants, and Rights

<b>8. [M89&num;11] A company issued rights to its existing shareholders without consideration. The rights allowed the recipients to purchase unissued common stock for an amount in excess of par value. When the rights are issued, which of the following will be interested? Additional Common StockPaid-In Capital a. b. c. d.

Yes Yes No No Yes No No Yes

<b>9. [M87&num;34] A company issued rights to its existing shareholders to purchase, for $30 per share, unissued shares of $15 par value common stock. Additional paid-in capital will be credited when the Rights Are IssuedRights Lapse a. b. c. d.

Yes No No Yes No No Yes Yes

Business Combinations

<b>10. [M88&num;35] Company L acquired all of the outstanding common stock of Company M in exchange for cash. The acquisition price exceeds the fair value of net assets acquired. How should Company L determine the amounts to be reported for the plant and equipment and long-term debt acquired from Company M? Plant and EquipmentLong-Term Debt a. b. c. d.

Fair value Fair value M's carrying amount M's carrying amount M's carrying amount Fair value Fair value M's carrying amount

<b>11. [N87&num;29] A business combination occurs in the middle of the year. Results of operations for the year of combination would include the combined results of operations of the separate companies for the entire year if the business combination is a Pooling of InterestsPurchase a. b. c. d.

Yes Yes No No No Yes Yes No

Earnings per Share

<b>12. [M89&num;25] Antidilutive stock options would generally be used in the calculation of PrimaryFully Diluted Earnings per ShareEarnings per Share a. b. c. d.

Yes Yes No No Yes No No Yes

<b>13. [N86&num;32] In determining earnings per share in a complex capital structure, which of the following is a common stock equivalent? Nonconvertible Preferred StockStock Option a. b. c. d.

Yes Yes No No No Yes Yes No

DISCUSSION QUESTIONS

Stock Options

<b>1. (May 1972) Part a. Stock options are widely used as a form of compensation for corporate executives.

Required:

1. Identify five methods that have been proposed for determining the value of executive stock options.

2. Discuss the conceptual merits of each of these proposed methods.

Part b. On January 1, 1980, as an incentive to greater performance in their duties, Recycling Corporation adopted a qualified stock option plan to grant corporate executives nontransferable stock options to 500,000 shares of its unissued $1 par value common stock. The options were granted on May 1, 1980 at $25 per share, the market price on that date. All of the options were exercisable one year later and for four years thereafter providing that the grantee was employed by the Corporation at the date of exercise.

The market price of this stock was $40 per share on May 1, 1981. All options were exercised before December 31, 1981 at times when the market price varied between $40 and $50 per share.

Required:

What information on this option plan should be presented in the financial statements of Recycling Corporation at (1) December 31, 1980 and (2) December 31, 1981? Explain why this is acceptable.

<b>2. (November 1986) Wesley Company granted compensatory common stock options to its executives on January 1, 1983, the measurement date, for services to be rendered during 1983 and 1984. The quoted market price of Wesley's par value common stock exceeded the option price on January 1, 1983. The stock options were exercisable beginning on January 1, 1985, and they lapsed on December 31, 1985. Half of the stock options were exercised in 1985 and half were allowed to lapse. Required: a. How should Wesley determine the amount of compensation expense related to the compensatory stock options, if any, that should be recognized in its income statements for 1983, 1984, and 1985? Why? b. How should Wesley account for the exercise of the stock options? Justify the accounting recommended. c. How should Wesley account for the lapse of the stock options? Justify the accounting recommended. Treasury Stock <b> 3. (November 1979) For numerous reasons a corporation may reacquire shares of its own capital stock. When a company purchases treasury stock, it has two options as to how to account for the shares: (1) cost method and (2) par value method.

Required:

Compare and contrast the cost method with the par value for each of the following:

a. Purchase of shares at a price less than par value.

b. Purchase of shares at a price greater than par value.

c. Subsequent resale of treasury shares at a price less than purchase price, but more than par value.

d. Subsequent resale of treasury shares at a price greater than both purchase price and par value.

e. Effect on net income.

<b>4. (November 1985) Brady Company has 30,000 shares of $10 par value common stock authorized and 20,000 shares issued and outstanding. On August 15, 1984, Brady purchased 1,000 shares of treasury stock for $12 per share. Brady uses the cost method to account for treasury stock. On September 14, 1984, Brady sold 500 shares of the treasury stock for $14 per share. In October 1984, Brady declared and distributed 2,000 shares as a stock dividend from unissued shares when the market value of the common stock was $16 per share. On December 20, 1984, Brady declared a $1 per share cash dividend, payable on January 10, 1985, to shareholders of record on December 31, 1984. Required: a. How should Brady account for the purchase and sale of the treasury stock, and how should the treasury stock be presented in Brady's balance sheet at December 31, 1984? b. How should Brady account for the stock dividend, and how would it affect Brady's stockholders' equity at December 31, 1984? Why? c. How should Brady account for the cash dividend, and how would it affect Brady's balance sheet at December 31, 1984? Why? Business Combinations <b>5. (May 1973) The boards of directors of Kessler Corporation, Bar Company, Cohen, Inc., and Mason Corporation are meeting jointly to discuss plans for a business combination. Each of the corporations has one class of common stock outstanding; Bar also has one class of preferred stock outstanding. Although terms have not as yet been settled, Kessler will be the acquiring or issuing corporation. Because the directors want to conform to generally accepted accounting principles, they have asked you to attend the meeting as an advisor.

Required:

Consider each of the following questions independently of the others, and answer each in accordance with generally accepted accounting principles. Explain your answers.

a. Assume that the combination will be consummated August 31, 1983. Explain the philosophy underlying the accounting and how the balance sheet accounts of each of the four corporations will appear on Kessler's consolidated balance sheet in September 1, 1983 if the combination is accounted for as a

1. Pooling of interests.

2. Purchase.

b. Assume that the combination will be consummated August 31, 1983. Explain how the income-statement accounts of each of the four corporations will be accounted for in preparing Kessler's consolidated income statement for the year ended December 31, 1983 if the combination is accounted for as a

1. Pooling of interests.

2. Purchase.

c. Some of the directors believe that the terms of the combination should be agreed upon immediately and that the method of accounting to be used (whether pooling of interests, purchase, or a mixture) may be chosen at some later date. Others believe that the terms of the combination and the method to be used are very closely related. Which position is correct?

d. Kessler and Mason are comparable in size; Cohen and Bar are much smaller. How do these facts affect the choice of accounting method?

e. Bar was formerly a subsidiary of Tucker Corporation, which has no other relationship to any of the four companies discussing combination. Eighteen months ago Tucker voluntarily spun off Bar. What effect, if any, do these facts have on the choice of accounting method?

f. Kessler holds 2,000 of Bar's 10,000 outstanding shares of preferred stock and 15,000 of Cohen's 100,000 outstanding shares of common stock. All of Kessler's holdings were acquired during the first three months of 1983. What effect, if any, do these facts have on the choice of accounting method?

g. It is almost certain that Mrs. Victor Mason, Sr., who holds 5 percent of Mason's common stock, will object to the combination. Assume that Kessler is able to acquire only 95 percent (rather than 100 percent) of Mason's stock, issuing Kessler common stock in exchange.

1. Which accounting method is applicable?

2. If Kessler is able to acquire the remaining 5 percent at some future time—in five years, for instance—in exchange for its own common stock, which accounting method will be applicable to this second acquisition?

h. Since the directors believe that one of Mason's major divisions will not be compatible with the operations of the combined company, they anticipate that it will be sold as soon as possible after the combination is consummated. They expect to have no trouble in finding a buyer. What effect, if any, do these facts have on the choice of accounting method?

<b>6. (May 1977) Hanover Company and Case Company, both of which have only voting common stock, are considering a merger whereby Hanover would be the surviving company. The terms of the combination provide that the transaction would be carried out by Hanover exchanging one share of its stock for two shares of Case's stock. Before the date of the contemplated exchange, Hanover had purchased 5 percent of Case's stock, which it holds as an investment. Case, at the same date, owns 2 percent of Hanover's stock. All of the remaining outstanding stock of Case will be acquired by Hanover in this contemplated exchange. Neither of the two companies has ever had an affiliation as a subsidiary or division of any other company. Required: a. Without enumerating specific criteria, how is a determination made as to whether a business combination is accounted for as a pooling of interests or as a purchase? b. Based only on the preceding facts, discuss the specific criteria that would qualify or disqualify this business combination as being accounted for as a pooling of interests. c. What additional requirements (other than those discussed in b above) must be met in order to account for this business combination as a pooling of interests? <b>7. (May 1987) There are two methods of accounting for business combinations, purchase and pooling of interests.

Required:

a.

1. What is the rationale for accounting for a business combination as a purchase? <b>Do not discuss the specific criteria for accounting for a business combination as a purchase. 2. In a business combination accounted for as a purchase, how should the amount of goodwill at acquisition be determined? 3. In a business combination accounted for as a purchase, how should goodwill be amortized? b. 1. What is the rationale for accounting for a business combination as a pooling of interests? <b>Do not discuss the specific criteria for accounting for a business combination as a pooling of interests. 2. In a business combination accounted for as a pooling of interests, when both companies use the same methods of accounting, how should the stockholders' equity be accounted for? Earnings per Share <b>8. (November 1978) The earnings-per-share data required of a company depend on the nature of its capital structure. A corporation may have a simple capital structure and only compute earnings per common share or may have a complex capital structure and have to compute primary earnings per share and fully diluted earnings per share.

Required:

a. Define the term common stock equivalent and describe what securities would be considered common stock equivalents in the computation of earnings per share.

b. Define the term complex capital structure and discuss the disclosures (both financial and explanatory) necessary for earnings per share when a corporation has a complex capital structure.

<b>9. (May 1970) APB Opinion No. 15 discussed the concept of common stock equivalents and prescribes the reporting of primary earnings per share and fully diluted earnings per share.

Required:

a. Discuss the reasons securities other than common stock may be considered common stock equivalents for the computation of primary earnings per share.

b. Define the term senior security, and explain how senior securities that are not convertible enter into the determination of earnings-per-share data.

c. Explain how convertible securities are determined to be common stock equivalents and how those convertible senior securities that are not considered to be common stock equivalents enter into the determination of earnings-per-share data.

d. Explain the treasury stock method as it applies to options and warrants in computing primary earnings-per-share data.

<b>10. (May 1974) Earnings per share (EPS) is the most featured single financial statistic about modern corporations. Daily published quotations of stock prices have recently been expanded to include a times earnings figure for many securities, which is based on EPS. Often the focus of analysts' discussions will be on the EPS of the corporations receiving their attention. Required: a. Explain how dividends or dividend requirements on any class of preferred stock that may be outstanding affect the computation of EPS. b. One of the technical procedures applicable in EPS computations is the treasury stock method. 1. Briefly describe the circumstances under which it might be appropriate to apply the treasury stock method. 2. There is a limit to the extent to which the treasury stock method is applicable. Indicate what this limit is, and give a succinct indication of the procedures that should be followed beyond the treasury stock limits. c. Under some circumstances convertible debentures would be considered common stock equivalents, and under other circumstances they would not be. 1. When is it proper to treat convertible debentures as common stock equivalents? What is the effect on computation of EPS in such cases? 2. In case convertible debentures are not considered as common stock equivalents, explain how they are handled for purposes of EPS computations. SELECTED ADDITIONAL READINGS Single texts covering the topics raised in this chapter do not exist. Readers interested in pursuing these topics in more depth are advised, therefore, to consult the following articles: Stock Dividends and Stock Splits Asquith, P.; P. Healey; and K. Palepu. ``Earnings and Stock Splits. The Accounting Review, July 1989, pp. 387&ndash;403. Foster, Taylor W. III, and Don Vickrey. ``The Information Content of Stock Dividend Announcements. The Accounting Review, April 1978, pp. 360&ndash;70. Liljeblom, E. ``The Informational Impact of Announcements of Stock Dividends and Stock Splits. Journal of Business Finance and Accounting, Winter 1989, pp. 681&ndash;98. Millar, James A. ``Split or Dividend: Do the Words Really Matter? The Accounting Review, January 1977, pp. 52&ndash;55. Pusker, Henri C. ``Accounting for Capital Stock Distributions (Stock Split-Ups and Dividends). New York CPA, May 1971, pp. 347&ndash;52. Stock Options Alvin, Gerald. ``Accounting for Investment and Stock Rights: The Market Value Method. CPA Journal, February 1973, pp. 126&ndash;31. Boudreaux, Kenneth J., and Stephen A. Zeff. ``A Note on the Measure of Compensation Implicit in Employee Stock Options. Journal of Accounting Research, Spring 1976, pp. 158&ndash;62. Milne, R. A.; G. A. Vent; and R. Neumann. ``Accounting for Variable Stock Options. Journal of Accounting, Fall 1987, pp. 333&ndash;38. Noreen, E., and M. Wolfson. ``Equilibrium Warrant Pricing Models and Accounting for Executive Stock Options. Journal of Accounting Research, Autumn 1981, pp. 384&ndash;98. See also, D. Galai. ``A Note on `Equilibrium Warrant Pricing Models and Accounting for Executive Stock Options.' Journal of Accounting Research, Fall 1989, pp. 313&ndash;15. Rogers, Donald R., and R. W. Schattke. ``Buy-Outs of Stock Options: Compensation or Capital? Journal of Accountancy, August 1972, pp. 55&ndash;59. Smith, Clifford W., and Jerold L. Zimmerman. ``Valuing Employer Stock Option Plans Using Option Pricing Models. Journal of Accounting Research, Autumn 1976, pp. 357&ndash;64. Smith, Ralph E., and Leroy F. Imdieke. ``Accounting for Stock Issued to Employees. Journal of Accountancy, November 1974, pp. 68&ndash;75. Wallace, W. ``The Effects of Delays by Accounting Policy-Setters in Reconciling the Accounting Treatment of Stock Options and Stock Appreciation Rights. The Accounting Review, April 1984, pp. 325&ndash;41. Weygandt, Jerry J. ``Valuation of Stock Option Contracts. The Accounting Review, January 1977, pp. 40&ndash;51. Business Combinations Anderson, John C., and Joseph G. Louderback III. ``Income Manipulation and Purchase-Pooling: Some Additional Results. Journal of Accounting Research, Autumn 1975, pp. 338&ndash;43. Brenner, Vincent C. ``Empirical Study of Support for APB Opinion No. 16. Journal of Accounting Research, Spring 1972, pp. 200&ndash;208. Defliese, Philip L. ``Business Combinations Revisited. D. R. Scott Memorial Lectures in Accountancy, vol. 6 (Columbus: University of Missouri, 1974). Emanuel, David M. ``Accounting for Business Combinations. Australian Accountant, October 1973, pp. 518&ndash;22, 525&ndash;26. Foster, William C. ``Illogic of Pooling. Financial Executive, December 1974, pp. 16&ndash;21. Gaertner, James F. ``Proposed Alternatives for Accounting for Business Combinations: A Behavioral Study. Abacus, June 1979, pp. 35&ndash;47. Gagnon, Jean-Marie. ``Purchase-Pooling Choice: Some Empirical Evidence. Journal of Accounting Research, Spring 1971, pp. 52&ndash;72. Hong, Hai; Robert S. Kaplan; and Gershon Mandelker. ``Pooling vs. Purchase: The Effects of Accounting for Mergers on Stock Prices. The Accounting Review, January 1978, pp. 31&ndash;47. Mian, S. L., and C. W. Smith, Jr. ``Incentives for Unconsolidated Financial Reporting. Journal of Accounting and Economics, January 1990, pp. 141&ndash;72. Mohr, Rosanne M. ``Unconsolidated Finance Subsidiaries: Characteristics and Debt/Equity Effects. Accounting Horizons, March 1988, pp. 27&ndash;34. Whittred, G. ``The Derived Demand for Consolidated Financial Reporting. Journal of Accounting and Economics, December 1987, pp. 259&ndash;86. Earnings per Share Arnold, Donald F. ``Earnings per Share: An Empirical Test of the Market Parity and Investment Value Methods. The Accounting Review, January 1973, pp. 23&ndash;33. Coughlan, J. W. ``Anomalies in Calculating Earnings per Share. Accounting Horizons, December 1988, pp. 80&ndash;88. Ellon, Samuel. ``Earnings per Share Can Be Misleading. Journal of Business Finance and Accounting, Summer 1975, pp. 239&ndash;42. Gibson, Charles H., and John Daniel Williams. ``Should Common Stock Equivalents Be Considered in Earnings per Share? CPA Journal, March 1973, pp. 209&ndash;13. Mautz, R. D., and T. J. Hogan. ``Earnings per Share Reporting: Time for an Overhaul. Accounting Horizons, Spring 1989, pp. 21&ndash;27. Parker, James E., and Barry E. Cushing. ``Earnings per Share and Convertible Securities: A Utilitarian Approach. Abacus, June 1971, pp. 29&ndash;38. Rice, Steven J. ``The Information Content of Fully Diluted Earnings per Share. The Accounting Review, April 1978, pp. 429&ndash;38. Shank, John K. ``Earnings per Share, Stock Prices, and APB Opinion No. 15. Journal of Accounting Research, Spring 1971, pp. 165&ndash;70. Tritschler, Charles A. ``Dilution and Counter-Dilution in Reporting for Deferred Equity. Accounting and Business Research, Autumn 1971, pp. 274&ndash;83. Vigeland, R. L. ``Dilution of Earnings per Share in an Option Pricing Framework. The Accounting Review, April 1982, pp. 348&ndash;57. Wiseman, Donald E. ``Holding Loss/Gain as an Alternative to EPS Dilution.'' Accounting Horizons, December 1990, pp. 18&ndash;34.

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